Compared with valuation methods such as price-to-book ratio, price-to-sales ratio and DCF, price-to-earnings ratio is favored by investors because of its rich meaning, easy data and easy calculation. It is no exaggeration to say that it is the most widely used investment method for investors.

However, surprisingly, although the P / E ratio seems simple, many investors will misuse and misuse the P / E ratio, such as not knowing which P / E ratio to use, miscalculation, ignoring the scope or premise of application, and giving the conclusion of overvaluation or undervaluation directly based on the P / E ratio.

Based on this, this paper mainly wants to take Budweiser Brewing Company APAC Limited, the beer giant and the largest brewer in Asia, as a case study to share with you the basic knowledge, scope of application, specific applications, advantages and disadvantages of the price-to-earnings ratio.

Without saying much, let's go straight to the topic.

Definition, formula and type of price-to-earnings ratio

The price-to-earnings ratio (Price-to-Earning Ratio,P/E) of a stock, which refers to the market price per share (P) divided by earnings per share (EPS), is usually used as an indicator of whether the stock is overvalued or undervalued. In addition, the price-to-earnings ratio directly connects the market value of an enterprise with its profitability, so it is widely used to evaluate whether the valuation of an enterprise is fair in the capital market.

There are two formulas for calculating the price-earnings ratio:

• The first is the most well-known, that is, price-to-earnings ratio (P / E) = market price per share (P) / earnings per share (EPS)

• The second is easily misused, that is, the price-to-earnings ratio (P / E) = the total market capitalization / profits attributable to the common shareholders of the parent company (hereinafter referred to as homing net profit).

But in practical application, many investors either want convenience, or because they do not have a deep understanding of the price-to-earnings ratio, they often directly divide the total market value by the net profit, so as to get the price-to-earnings ratio. But this is actually incorrect, and sometimes there is a big error between the price-to-earnings ratio calculated in this way and the real price-earnings ratio, because the net profit of a listed company can be divided into two parts, in addition to the home net profit, there are also net profits belonging to minority shareholders, which are called minority shareholders' profits and losses. Furthermore, it is not difficult to imagine that when the minority equity of a listed company is relatively large, the profit and loss of minority shareholders will account for a larger proportion of net profit, which will directly affect the calculation results of homing net profit and price-earnings ratio.

For example, CITIC Limited, whose profits and losses account for a large proportion of the net profit of minority shareholders in Hong Kong stocks, made a net profit of HK $78.2 billion in 2019, of which the net profit of its mother was HK $53.9 billion and that of minority shareholders was HK $24.3 billion. Calculated on the basis of the latest total market value (July 27) of HK $217 billion

I) if the net profit of HK $78.2 billion is mistakenly used as the denominator, CITIC Limited's static price-to-earnings ratio is 2170Belgi2.77 times.

Ii) if the parent net profit of HK $53.9 billion is correctly used as the parent item, CITIC Limited's static price-to-earnings ratio is 5394.03 times earnings. The difference between the two is 45%, thus it can be seen that when using the total market capitalization / homing net profit to calculate the price-earnings ratio, it should be noted that the denominator term is the homing net profit excluding the profit and loss of minority shareholders.

So why is the price-to-earnings ratio divided by total market capitalization by return net profit, rather than directly divided by net profit?

This is mainly because the total market value in the numerator corresponds to the total value enjoyed by the common shareholders of the parent company; therefore, the denominator term in the price-to-earnings ratio formula should also correspond to the net profit enjoyed by the common shareholders of the parent company. it should not include the net profit enjoyed by minority shareholders, so that the inherent logic of the formula can be consistent.

On the basis of preparing to use the formula for calculating the price-to-earnings ratio, it is also necessary for investors to distinguish four different price-to-earnings ratios, namely:

• I) static price-to-earnings ratio, abbreviated as P LYR E based on Last Year Ratio

• Ii) rolling price-to-earnings ratio, abbreviated as P TTM E based on trailing twelve months

• Iii) dynamic P / E ratio, abbreviated as Pmax E 2020E (P based on Expected E)

• And iv) annualized price-to-earnings ratio.

Next, take Budweiser Brewing Company APAC Limited as an example to analyze the meaning of the four kinds of price-to-earnings ratio as well as their advantages and disadvantages.

I) static P / E ratioEqual to the current total market value divided by last year's return net profit. Budweiser Brewing Company APAC Limited, for example, has a static price-to-earnings ratio equal to the current total market capitalization (HK $317.2 billion), divided by last year's return net profit (HK $6.993 billion in 2019), equal to 45 times.

Ii) Rolling P / E ratioEqual to the current total market value divided by the net return to home for the last 12 months Budweiser Brewing Company APAC Limited, for example, has a rolling price-to-earnings ratio equal to the current total market capitalization (HK $317.2 billion), divided by the last 12 months' return net profit (2019Q2~2020Q1 's home net profit is HK $4.791 billion), which is equal to 66 times.

Iii) dynamic P / E ratio, equal to the current total market value, divided by the projected net return profit in 2020 Budweiser Brewing Company APAC Limited, for example, has a rolling price-to-earnings ratio equal to the current total market capitalization (HK $317.2 billion), divided by the projected 2020 net profit (analysts on Wind unanimously expect it to be HK $5.153 billion in 2020), which is 62 times.

Iv) annualized price / earnings ratioEqual to the current total market value divided by the annualized value of the quarterly net profit disclosed. Take Budweiser Brewing Company APAC Limited as an example, its rolling price-earnings ratio is equal to the current total market value (HK $317.2 billion), divided by the annualized net profit of Q1 in 2020 (the annualized net profit of Q1 in 2020 is-HK $318 million and the annualized net profit is-HK $1.272 billion).

To sum up, also calculating the price-to-earnings ratio, Budweiser Brewing Company APAC Limited's four kinds of price-to-earnings ratio differ greatly, which has a great impact on investors' evaluation of Budweiser Brewing Company APAC Limited's valuation. For example, when investors analyze Budweiser Brewing Company APAC Limited's valuation based on static price-to-earnings ratios and annualized net income, the conclusions will vary widely.

So, in practice, what kind of price-to-earnings ratio should investors base on to make investment decisions?

This mainly involves the analysis of the advantages and disadvantages of these four kinds of price-to-earnings ratio.

In conclusion, it is suggested that the valuation of listed companies should be based on dynamic P / E ratio, supplemented by rolling P / E ratio, and not based on static P / E ratio and annualized P / E ratio. The specific reasons are as follows:

I) first of all, for the static P / E ratioThe reason for the low reference value is that last year's net profit is already in the past and does not have a strong causal relationship with the enterprise's profitability this year and in the future. after all, investment depends more on the future profitability of the enterprise.

Ii) secondly, for annualized price-to-earnings ratioThe reference value is the lowest, because on the one hand, the calculation method of return net profit is unscientific and has serious logical defects. For example, for Budweiser Brewing Company APAC Limited, although he lost money in the first quarter of this year, for the whole year, Budweiser Brewing Company APAC Limited's return net profit is a high probability event. however, based on the net profit of homing in the first quarter of this year, the annualized net profit in 2020 is-1.272 billion Hong Kong dollars (a loss of 1.272 billion Hong Kong dollars), which is not in line with Budweiser Brewing Company APAC Limited's actual situation, no matter in terms of logic or actual operation. Therefore, Budweiser Brewing Company APAC Limited's annualized price-to-earnings ratio of-249 times this relatively ridiculous value.

On the other hand, in the actual operation, some enterprises have obvious off-season and peak season. When some enterprises just enter the off-season, the return net profit in that quarter will be very low or even negative, resulting in a falsely high price-to-earnings ratio, which is very likely to cause the market capitalization of the price-earnings ratio to be unreasonable, which may exceed 100 times or, like Budweiser Brewing Company APAC Limited, become-249 times. By the same token, when some enterprises enter the peak season, then the return net profit in the current season will increase substantially, at this time to convert the adult return net profit, it will cause the price-to-earnings ratio to appear very low, perhaps only 8 or 9 times, which is unreasonable.

Therefore, the defect of annualized P / E ratio is very obvious, and it is easy to distort the annual return net profit of the enterprise, thus distorting the return net profit, resulting in the calculated P / E ratio is meaningless.

Iii) for rolling P / E ratioRelatively objectively reflects the current price-to-earnings ratio, because it uses the return to home net profit of the last 12 months, and it is constantly rolling update, relatively more timely reflect the real earnings of the enterprise. But its defect is still does not reflect the future, after all, investors buy stocks, the current performance does not mean that the future performance continues to grow, if the future performance decline, then the rolling P / E ratio will be higher, so the rolling P / E ratio is only suitable for enterprises with sustained and steady growth in performance. However, even enterprises with stable performance may have non-recurring profits and losses in a certain quarter, then the return net profit of enterprises will be distorted, resulting in the distortion of price-to-earnings ratio.

Therefore, it is suggested that the rolling price-earnings ratio should be used as one of the reference indicators to evaluate whether the enterprise valuation is fair or not.

Iv) finally, dynamic price-to-earnings ratio.From a logical point of view, the expected return net profit as the denominator is the most reasonable, after all, investors buy enterprises buy the future, only optimistic about its future profitability, will consider buying. However, the dynamic price-to-earnings ratio is a double-edged sword, which requires investors to forecast the return net profit correctly, otherwise, if the forecast is wrong, it will mislead investment decisions.

To sum up, if investors are more sure that they can predict the return net profit of the covered target, then they can consider dynamic price-earnings ratio as the main factor, supplemented by rolling price-earnings ratio.

II. Applicable scope and specific application of price-to-earnings ratio

After understanding the definition of price-earnings ratio, two calculation formulas and four types, it is more important for investors to grasp: I) the applicable scope of price-earnings ratio, that is, what types of enterprises are suitable for price-earnings ratio valuation; ii) what should be paid attention to when applying the price-earnings ratio valuation method.

As for I) the scope of application of the price-to-earnings ratio, it is generally believed that it is more suitable for mature enterprises with true-stable-sustainable profits. In other words, enterprises in the loss stage or with negative return net profit are not suitable to be valued by the price-earnings ratio, because the negative price-earnings ratio has no investment significance, just as Budweiser Brewing Company APAC Limited's annualized price-earnings ratio of-249 times does not have any practical significance. In addition, periodic enterprises with large earnings fluctuations, such as iron and steel, non-ferrous metals, cement, petrochemical and so on, are not suitable to be valued by the price-to-earnings ratio, because the return net profit is often in the "distortion" stage. Finally, the growing enterprises whose net profit is in a period of rapid growth are not suitable to be valued by the price-to-earnings ratio, because the net profit as a denominator changes too fast in a short period of time.

As for the specific application of ii) P / E ratio. Because the numerator in the price-earnings ratio method, that is, the total market value, exists objectively, and the net profit of attribution, as the denominator, is easily affected by accounting treatment and easily adjusted or manipulated, so the key to the calculation is the net profit of homing. It is extremely important to understand and calculate the accurate return net profit. If the means of manipulating or adjusting profits can not be identified, then the price-to-earnings ratio method can only be led by the nose by listed companies.

Specifically, when applying the price-to-earnings ratio valuation method, we need to pay special attention to the following three points:

First:After qualitatively evaluating the appropriate P / E ratio for an enterprise, the next step should be to choose which P / E ratio to use. As mentioned earlier, it is recommended to use the expected P / E ratio, supplemented by a rolling P / E ratio.

Second:Rational analysis of the profit quality of enterprises, dike value trap (undervaluation trap).

Because the return net profit is easy to be manipulated, adjusted and covered up, which leads to distortion, which directly affects the reliability of the price-to-earnings ratio. Therefore, the profit quality of the enterprise must be analyzed rationally and the return net profit of the enterprise should be calculated conservatively as far as possible.

For example, when calculating the price-to-earnings ratio, we need to use the homing net profit after deducting non-recurring profits and losses, because listed companies have too many means to adjust profits, so we must pay attention to the distinction, especially when the net profit is mainly contributed by non-recurring profits and losses. This is to prevent the undervaluation trap due to the distortion of net profit. For example, Meikailong, which has been analyzed by Zhihu Inc. blogger Chu Shanjun, has a valuation of only 9 times earnings, but more than 1.5 billion of its profits are brought about by changes in the fair value of investment real estate and cannot bring cash flow, which is a hidden valuation trap.

For example, the return to the mother of net profit is brought to the downstream pressure goods, pay attention to the changes of accounts receivable. The income and profits obtained from the downstream pressure goods are obviously not sustainable, and the statement shows that the growth rate of accounts receivable is greater than that of operating income. For example, East Ejiao, which reported a thunderstorm in mid-2019 (2019Q2 lost about 200 million yuan in a single quarter), its operating income fell by 0.46% in 2018 and 24% in the first quarter of 2019, but accounts receivable increased by 118% and 17% respectively.

Therefore, the quality of forecasting earnings is very important, which requires system-wide knowledge of financial statements.In the future, you can pay more attention to our Futu Niuniu (nickname: valuation Research)。

Third:After calculating the price-earnings ratio, we can not judge whether the valuation of a company is expensive or cheap simply according to the size of the price-earnings ratio, neither the bigger the price-earnings ratio, the better, nor the smaller the price-earnings ratio, the better. It needs to be analyzed in combination with the company's business situation, business model, competitors and so on. Therefore, investors need to compare the calculated P / E ratio horizontally and vertically, that is, compared with competitors in the same industry, but also with their own past P / E ratio. In addition, the reciprocal of the price-to-earnings ratio, the yield, can be calculated and compared with the risk-free yield (10-year U.S. Treasury bonds) to look at the performance-to-price ratio and risk compensation of investing in stocks.

Conclusion: only by using the price-to-earnings ratio correctly can it be meaningful.

As mentioned at the beginning of the text, although the price-to-earnings ratio is easy to calculate and is the most frequently used valuation index for investors, it is not as easy as imagined to make good use of the price-to-earnings ratio valuation method:

First of all, in the face of a company, investors should first judge whether it is suitable to use the price-to-earnings ratio method to value. Second, if appropriate, which price-to-earnings ratio should be used? Then, when determining to use the dynamic price-earnings ratio, how to rationally analyze the earnings quality of the enterprise, so that the "homing net profit", which is the key to the calculation, will not be distorted? Finally, after calculating the dynamic P / E ratio, how to make good use of the dynamic P / E ratio? What comparisons should be made?

A thousand words can be summed up as a correct nonsense, that is, it is meaningful to evaluate the value of an enterprise only if the price-to-earnings ratio is used correctly.